Last updated on October 28th, 2020
When talking about stock options there are many common questions that come up.
- Which strike price should I trade?
- Should I buy or sell the options?
- Should I use monthly or weekly options?
The reason these questions can be tricky is that there is no perfect answer that fits each situation. It all depends on your outlook and what you are looking to accomplish with that trade.
Let’s talk about the different expiration cycles in more detail.
Over the past few years weekly options have become very popular with traders because in most cases they provide a cheap way for the retail trader to get into a trade. Weekly options expire each Friday, which means they are great products for traders looking for quick movement in the stock or ETF.
However, are they always the best products to use?
It all depends on your outlook for the stock or ETF. Here is a guide to trading options depending on your choice of time frame.
Before we go any further with this discussion let’s talk about the Greeks for a moment. Options traders use the Greeks to track how the price of an option will change based on changing market conditions.
Take Delta for example.
The Delta of an option tells a trader how much the price of an option will change for every $1 move in the stock. So if an Apple 95 call option has a delta of .50 that means for every $1 move that Apple stock makes the 95 call will change by $.50.
This can be helpful as traders try and plan out their trade.
The second Greek that can be very helpful is called Gamma. The Gamma of an option tells the trader how much the Delta is going to change for every $1 move in the stock.
So let’s go back to our Apple 95 call that had a delta of .50. We know that if Apple moves from 95-96 the call option will increase in value by $.50. However, the Delta will also change as the price of the stock changes.
Once Apple goes from $95 to $96 per share the Delta could then be at .75. This means the Delta has changed by .25 (from .50 – .75). The .25 change in the delta after Apple moved $1 is known as the Gamma. So if Apple continues to rally further from $96 to $97 the call option will increase in value by $.75 for that $1 move in Apple.
In other words Gamma can be viewed as the fuel that is thrown on the fire.
What’s Your View?
Going back to our discussion on whether we should use the monthly or weekly options, we said that it all depends on our outlook for the stock or ETF.
If we are expecting a quick move within the next few days then the weekly options will give us the most bang for our buck. This is due to the fact that Gamma is higher the closer we get to expiration (see chart below).
As a result of the higher gamma in the weekly options the price of those options will react quicker to movement in the stock. We will see more powerful moves as long as the move happens quick enough.
Remember options are decaying assets which means the longer we hold them the more time value comes out.
As long as the move happens quick enough then we can overcome the time decay.
If we are expecting a directional move in the stock but the overall market is moving slower the monthly options will be a better choice.
The Gamma won’t be as high which means the options react slower to changes in the stock price but it also means the time decay won’t be as high.
As a result if the move takes longer than expected we still have a good chance of being profitable.
Monthly or Weekly Options?
To summarize, if you are expecting a quick move in the stock or ETF then the weekly options will give you the best potential for a home run play.
It is a more aggressive way of taking the trade.
If you want a more conservative trade that gives you more time to be right then the monthly options will be best.
While the Greeks can seem complex at first, as you can see just knowing some of the basics will help you increase the odds of success.
Options are very flexible products and allow us to structure trades to fit our outlook on the markets unlike any other product out there.
Options Fast Track
We cover the Greeks in detail as part of our Options Fast Track Course which will walk you through how to trade options at NetPicks. Knowing how an option will react to changing market conditions will lead to more profitable results.